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Pittsburgh Tribune-Review: “Beware of official data on inflation”

In my February 28th, 2006, column for the Pittsburgh Tribune-Review I continued my warning about official data on inflation.

(For some reason, all but two of my Trib columns from late December 2005 through early April 2006 are unavailable on-line. They appeared only in print. I thank the editors of the Trib for sending to me the texts of these columns.)

You can read the column beneath the fold.

Beware of official data on inflation

Pick up a copy of today’s New York Times. There’s a good chance that in it you’ll encounter the claim that middle-class Americans live no better today than they did in the 1970s.

If you’re like me — namely, someone who remembers well the America of 30 years ago — you’ll look around in 2006 and wonder “How can this be?” You’ll notice that you and your neighbors today all have cell phones and that your children snicker when you tell them that not so long ago all telephones were fastened to walls by cords.

You’ll notice that people diagnosed with cancer today are more likely to survive that illness; you’ll notice that the variety of offerings in supermarkets is much larger than it was in the 70s; you’ll notice that even the cheapest television today has a color picture and a remote control; you’ll notice that pocket calculators that now come in cereal boxes are more powerful than were calculators that once cost $100.

In short, you’ll notice ordinary people enjoying incredible material wealth that 30 years ago was available, if at all, only to the very wealthy.

But as I wrote in my previous column, official data proclaim that the average, inflation-adjusted wage rate earned by the typical American worker is today no higher than it was when Gerald Ford lived in the White House.

A major problem with this data is that adjusting prices and wages for inflation is a surprisingly tough challenge. In addition to the difficulty that I discussed in my earlier column, an even bigger problem with the way statisticians adjust prices and wages to account for inflation is that quality changes are often ignored.

In 1976 a mid-priced new car cost about $5,000. A mid-priced car today costs about $20,000. We all know, though, that the dollar bought more in 1976 than it buys today. So everyone agrees that it’s wrong to say that a mid-priced car today is four times more expensive than was such a car in 1976. Before determining how much a car today costs compared to a car in 1976, we must adjust prices to account for the inflation that took place since then.

The most common way to do this adjustment is to track changes in the Consumer Price Index (CPI). The CPI shows that it takes $3.55 today to buy what $1 bought on Jan.1, 1976. So the “real” price of that new car today, expressed in 1976 dollars, is $5,633.80.

Although not four times more pricey than its 1976 counterpart, today’s new car, according to official data, nevertheless does cost more in “real” dollars — an additional 633.8 1976 dollars, to be precise (or an additional 2,250 2006 dollars).

So official data conclude that Americans today pay more real dollars for automobiles.

The problem with this conclusion is that the thing we today call a “car” differs vastly from the thing that we called a “car” in 1976. Unlike a mid-priced car today, the mid-priced car in 1976 had no air bags, no power windows, no power door locks, no heated seats, no tilt steering wheel, and no CD player. It got fewer miles per gallon, needed tune-ups much more frequently, and was more likely to kill its occupants in collisions. Its exterior rusted sooner.

What to conclude, then, from the fact that the real price of an ordinary car is higher today than in years past? If you want to argue that the deregulation, tax-rate cuts, increased immigration and expansion in global trade that date back to the late 1970s and continue today have harmed Americans, you insist that the higher real price of cars is evidence that middle-class Americans are struggling just to maintain the lifestyles they enjoyed in the 1970s. And you point out that not only has the real price of cars risen, so too have the real prices of other things — especially those of housing, higher education and health care.

But the correct stance is to recognize that the quality of almost everything we buy today is much higher than in the past. For example, houses are larger and better equipped, the returns to higher education have increased substantially and medical care is less invasive, less painful and more successful than 30 years ago. Because procedures for adjusting for inflation largely ignore these quality improvements, official data on prices and wages significantly underestimate the improvements in our living standards.